What is the Average Directional index?

ADX full form denotes Average Directional Index is a calculation based on expansion and contraction which is developed from the price range of security with time.

The use of ADX in the stock market is for measuring the trend of the market. It finds the price range values to estimate the required movement in the stock.

This blog post is for traders who want to get knowledge on ADX from its basics.

ADX is developed by Welles Wilder and attempts to find the positive or negative direction of a stock market trend. It is a component which is taken from the direction movement system.

ADX or Average Directional Index is an indicator which is also known as a “trend Strength Indicator. It helps traders to find the profit potential by reducing their risk while trading. It is a leading indicator which reveals the trend through ADX value before the breakout occurs.

In stock markets, detecting a strong trend while trading in equities is essential which can be done using the ADX indicator. It helps in analysing a strong directional move while chasing a trend.

As you know, stock prices often remain more in consolidation and less in trending moves, this is the reason behind using the ADX indicator strategy to determine whether the trend is bearish or bullish.

In the indicator, three lines develop the Direction Movement Index (DMI):

1. DI+ Green Line

2. DI- Red Line

Using the strategy of the above three lines, ADX is used to trade. There are several ways such as crossovers, expansions and contractions which provides a range for the trader in stock markets.

Let’s move on to understand these strategies in depth.

The use of the ADX indicator formula develops the strength of an ongoing trend. According to Welles Wilder, when a trend is present in stock, the ADX is above 25. Also, the DMI is somewhere between 0-100.

Remember that ADX strategy is known as non-directional which shows a clear reversal prior trend. Therefore the ADX will be above 25 when the reversal starts. To estimate this, the following formula can be crucial.

• If DI- is above DI+ = ADX above 25 = Indicates a strong downtrend

• If DI+ is above DI- = ADX above 25 = Indicates a strong uptrend

The direction of the ADX is important to read the strength of the trend. Make sure to understand the above concept with the ADX line i.e., when the ADX line is rising, the trend strength will also increase whereas, if the ADX is falling, the strength of the trend will decrease.

Note: There is a common misconception among traders that a falling ADX determines reversing the trend to another direction. However, if the ADX line is falling, it simply means that the strength of the trend is weakening. If the ADX is above 25, and the line falls, assume that it is getting weaker.

ADX indicator is less popular when compared to MACD and RSI, however, it helps in identifying one of the strongest trends in the market. The following table denotes the ADX value and its trend strength through the value.

 ADX Value Trend Strength 75-100 Extremely Strong Trend 50-75 Very Strong Trend 25-50 Strong Trend 0-25 Weak Trend

Since the values are important to denote a trend, it is equally important to understand the signs of low and high ADX. When ADX is below 25 it predicts a weak trend because it arrives in the zone of accumulation or distribution.

Usually, the price moves from the low ADX to indicate a breakout with a strong trend. The high and low ADX ascertains a support and resistance zone for a stock which in turn breaks out into a trend.

As mentioned above, the ADX indicator is rarely used by traders to indicate the trend direction. Traders are most likely to use ADX with moving averages or support/resistance.

To analyse price movement, the ADX indicator is used with support and resistance levels. A range is identified in the process where a combination of ADX is analysed with the price of the security traded. The range consists of the higher levels and lower levels with ADX readings. It helps in finding out the trends that were initiated with the price range.

It is also one of the reliable price indicators that helps traders and investors not fall for a false breakout. Thus, one can find ranging or trending markets through this indicator.

In a market that is heading substantially upward, ADX values will grow to increasingly high levels. However, if ADX levels begin to fall even as prices climb, this divergence between price movement and the ADX may indicate that the market is losing momentum and is thus due for a shift to the negative. As we learned above, the market may show weak signals when the ADX line falls.

ADX indicator strategy is used as a momentum or divergence indicator that can signal market reversal during the price movement. In this case, analysts will closely follow price movement for further indicators of a possible trend change, with the ADX divergence service as a prior indicator for it.

The Bottom Line

The ADX indicator is an unpopular yet crucial indicator for traders and analysts. Due to its lagging nature, it is a reliable and range-identifying indicator. It correctly identifies the market range before a breakout using ADX values.

Remember that it can produce better results when used with moving averages or RSI. We hope that now you will consider implementing the ADX indicator while analysing stocks.

Key Takeaways

• ADX analyses the positive or negative strength of the market

• ADX indicator is lagging in nature

• DMI consists of 3 lines – DI-, ADX and DI+

• DMI is measured between 0-100

• ADX line shows a directional trend through prior movements

• ADX value denotes, weak, strong, very strong and extremely strong trends through the values of 0-100

• If DI- is above DI+ = ADX above 25 = Indicates a strong downtrend

• If DI+ is above DI- = ADX above 25 = Indicates a strong uptrend

• If the ADX line is falling below 25, it means the sentiment and trend are weakening

• ADX indicator estimates price movement through support and resistance